The Secret Banks Don't Want You to Know About Prepaid Cards

Banks have a new hot-and-heavy love affair going -- with prepaid debit cards. As we've pointed out, banks stand to lose a lot of money due to new debit-card regulations, and that's on top of the money they lost when the government stepped in and put the kibosh on a lot of fees and rate hikes via the CARD Act. Banks have turned to prepaid cards because, at present, the legislation that protects consumers and their money when it comes to using ordinary debit cards doesn't apply to the prepaid cards.

As this article reveals, financial institutions are being very cagey when asked about their plans for expanding debit card use, but charts like the one featured in the article linked to above show that banks expect this segment of their business to grow very rapidly, up to about 7 million users by 2014.Consumer advocates are worried that consumers, especially lower-income people who have traditionally been the target market for prepaid cards, could be hurt by these lightly regulated products. "It looks like a regular debit card, but you don't have any mandatory protections in the case of a lost or stolen card," says Suzanne Martindale, an associate policy analyst at Consumers Union, a nonprofit organization that conducted research and wrote a report on prepaid cards and found that they're alarmingly lacking in many basic protections Americans take for granted.

For instance, holders of a traditional debit card that is tied to a bank, checking or savings account are limited by law to $50 in liability if they report a lost or stolen card within two business days. "What prepaid card customers have now, if anything, are voluntary protections," says Martindale, who speaks of "significant loopholes" in these conditions. "The voluntary protections aren't enough."

In addition to the lack of liability coverage, Martindale told WalletPop that it's up to the bank to make sure your money won't disappear if that bank fails -- an unnerving prospect. If you have a traditional bank account, FDIC insurance covers up to $250,000. Odds are, you'll never have that much in a savings or checking account. But what if you were a bank or a financial firm, with potentially hundreds of thousands of customers' money all pooled together in a single account? How much is covered then?

Worryingly, the answer seems to be: It depends on the bank. If the bank takes pains to hold good records indicating exactly whose dollars are whose, cardholders would likely be reimbursed in the event of a bank failure. Based on banks' failures at record-keeping in the case of foreclosures, though, it's not likely customers would put that much faith in them -- if they realized the consequences.

Martindale points out that many providers of prepaid cards use FDIC insurance as an assurance. "A lot of issuers say the bank is a member of FDIC, but that's not enough. That really is up to the issuers and the banks to make sure they're doing the proper accounting to get pass-through insurance. They're not required to do that now. It's very disturbing," she says.